Steve writes editorials for each issue of Forbes under the heading of “Fact and Comment.” A widely respected economic prognosticator, he is the only writer to have won the highly prestigious Crystal Owl Award four times. The prize was formerly given by U.S. Steel Corporation to the financial journalist whose economic forecasts for the coming year proved most accurate.

In both 1996 and 2000, Steve campaigned vigorously for the Republican nomination for the Presidency. Key to his platform were a flat tax, medical savings accounts, a new Social Security system for working Americans, parental choice of schools for their children, term limits and a strong national defense. Steve continues to energetically promote this agenda.

Good Returns With Less Risk? High Priest Of Dividends Shows How!

Priest: We definitely have a bond bubble. The biggest danger to my statement is we have insufficient aggregate demand around the world to absorb the resources that are available for production. So think of Economics 101, when people say that economics is the study of the allocation of scarce resources, land, labor, and capital.

The reality today is we’ve got a lot of labor in the world that’s unemployed. We have lots of idle plants in the world. We’re short demand for the utilization of those resources, so the biggest danger in the world is that we don’t get growth fast enough to absorb this.

Now the central bank and Bernanke I think said this publicly, “We’re kind of learning by doing.” Little scary statement, but he basically indicated that if we can get asset prices up, we’ll essentially have a trickle down. There’ll be people who benefit from higher asset prices. Those individuals will spend some of their money and it will trickle into the real economy. We’ve seen very little of that. The money has been created, but it’s trapped in the banks. It hasn’t gotten out into the real world through loans. Little bit of a pickup, but not sufficient.

Forbes: You make a distinction, an interesting one, before we get to stocks and pension funds, between private pension funds and state pension funds.

Priest: I used to serve on the board of the state of New Jersey’s pension funds, and there was one leader there who did a fantastic job. He made one decision back in the early 1980s: He put 70% of the fund into equities.

20 years later it was an amazing result. The problem that politicians have done is they’ve tried to use this as a piggy bank. They’ve kept raising the assumptions of returns and they’ve created a nightmare for the citizens of those respective states – and that includes New Jersey.

These assumed rates of return are almost impossible to deliver. One of the things I would argue that’s going on is the states have moved to higher risk assets but they’re not marked to market.

They’ve moved away from publicly traded assets such as stocks and even bonds, and they’ve gone into hedge funds and they’ve gone into private equity. I’m not sufficiently knowledgeable about hedge funds, but I do know a lot of private equity is not marked to market. That’s a wonderful business to be in if you don’t have to mark your assets to market. I think there’s a day of reckoning coming, certainly for California, even more so for Illinois, where they’re essentially broke with regard to their pension funds.

Forbes: So a lot of the valuations, like houses, were make believe?

Priest: I think a lot of the valuations are make believe. And I have to be careful with this. We have a number of states as clients. But I think, “The best disinfectant is sunlight.” I think it was Oliver Wendell Holmes that said that. To me, the truth shall set you free and you never, ever want to get strayed from the truth. I think transparency of valuation is critical to solving many of our nation’s problems.

Forbes: You made the point – and then we’ll get to the stocks – about GDP debt ratios. When you get to 90%, you’ve got a problem. After World War II, this country’s debt to GDP ratio was about a 100%, 125%.

Priest: Correct.

Forbes: We did good things. The debt didn’t go down, but the GDP went up. So by the late ’60s it was about 35% or 40%. It was done in a very non painful way.

Priest: Right.

Forbes: Can we do that again?

Priest: No. And I say that emphatically. Because when we came out of World War II, Japan was devastated, Europe was devastated. The only growth engine in the world was the United States of America. The amount of pent-up demand in the United States by itself was enormous.

There was huge pent-up demand for consumer durables, washing machines, autos, and so on, and there was no capacity. Then, when you added in the devastation that existed in Japan and in Germany, by the time you got around to supporting the Marshall plan, the rebuilding of Japan, it was a fantastic period for growth and we were able to grow our way out of that problem.

We also had a policy of going back to something called the 1946 Full Employment Act. And that act was passed in 1946 mainly for our politicians who were looking back after World War I, where we had the experience of the 1920s and then the Depression.

They charged the Fed with doing three things: no inflation, full employment and growth consistent with full employment. To this day that’s still the charge of the Fed, but serving three masters is very hard to do. When you look back on that time period, we basically did have full employment. We basically did have rapid growth. But we didn’t contain inflation.

Eventually we kept bond rates down through the 1950s and into the 1960s. But it was at terrible cost to the bond holder. They lost purchasing power. The loss was enormous. Then, basically, we enter the 1970s, and of course we know what happened then. It was stagflation and a serious problem.

Today it’s going to be incredibly difficult to grow our way out. Real GDP is dependent on two variables: growth in the workforce and productivity. Whatever you think the growth in the workforce is going to be, and in our case we need to grow 100,000 people a month in the employment world just to keep the unemployment rate the same.

We have about 130 million people employed in the U.S. Demography adds about 1.3 million a year. We’ve got to add about 100,000 to the workforce every month to keep the unemployment rate where it is. Getting 200,000 people to work in America right now is tough. Manufacturing’s not going to do it, so it’s the service economy. The service economy has lower wages, so when you look at real disposable income per capita, boy, the growth rate outlook there is very, very modest at best.

Forbes: Question related to the Obamacare Affordable Care Act, the huge cost coming on that. Are we going to see more and more what we saw this year, where job growth comes with part time? People don’t want full time employees and those liabilities, and they’ll do anything to get around that.

Priest: In some industries, I think you probably will see that. I think President Obama meant well in the sense of spending his first year on health care, and I think there is an issue with many, many Americans being uncovered. I think the means that was addressed to handle that problem was excessive. With hindsight, I would have suggested that he spent the first year on the wrong agenda.

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